Recession talk flared up on Friday as the 10-year Treasury yield tumbled below that of the 3-month Treasury. While this signal has a spot-on track record in predicting a recession, there are reasons to take it with a grain of salt now. But another key economic indicator also flashed a worrying sign. The breakout of copper prices last month signaled that 2019 might be like 2016. That year saw the global economy rebound and the Dow Jones start a new leg to much greater heights. Yet that breakout failed on Friday, casting doubt on whether a new global upturn is at hand.
The 10-year Treasury tumbled 10 basis points to 2.44%, the lowest since late 2017, while the 3-month Treasury eased just 2 basis points. When long-term rates fall below short-term rates, it’s called an inversion because it’s upside down relative to the way things usually work during an economic expansion.
Meanwhile, the Dow Jones industrial average shed 460 points, or 1.8%, while the S&P 500 lost 1.9% and the Nasdaq composite 2.5%.
Copper prices fell 2%, though part of the weakness stemmed from the stronger dollar. The U.S. Dollar Index, which measures the greenback against a basket of advanced-economy currencies, rose 0.75%. The dollar has remained stubbornly strong, despite the Fed’s dovish shift.
Dr. Copper’s Prognosis For Dow Jones
The industrial metal earned the nickname Dr. Copper for its ability to discern global economy ups and downs. Its track record in recent years has been impressive. After bottoming in January 2016 at $1.94 per pound, copper staged a mild recovery, then exploded higher after President Donald Trump’s election. Copper prices ranged from $3-$3.25 a pound from August 2017 through June 2018, anticipating the economic surge that peaked in the second quarter of last year.
Then copper fell into a seven-month funk, stuck between $2.60 and $2.87. That ended on Feb. 19, when copper prices broke above the trading range. They kept pushing higher, hitting $2.96. But prices had been receding lately and fell just below $2.85 on Friday. This will be a key chart to watch going forward.
Inverted Yield Curve Follows Weak Global Factory Data
Copper prices and Treasury yields both sank for related reasons on Friday. Manufacturing survey data published by IHS Markit indicated that euro zone manufacturing activity contracted the most in nearly six years. Activity in Germany fell for a third straight month. Meanwhile, Japanese factory activity also shrank, while U.S. activity grew at the weakest pace since June 2017. The rising odds of a hard Brexit, though hardly a sure thing, also may be creating a bid for safe assets.
Fed Rate Hike Mistake
The main takeaway from the inverted yield curve is that the Fed erred in hiking interest rates in December 2018, as should have been clear at the time. If the Fed were to immediately cut rates by a quarter point, then the yield-curve inversion would disappear. While the inverted yield curve probably does signal that the risk of recession is rising, it’s not a given. Global central bank bond buying, low inflation, and negative interest rates in Japan and now Germany are among the factors that complicate the typical yield-curve analysis.
Financial markets are now pricing in close to 60% odds of a rate cut by December. Bank stocks, particularly regional and super-regional banks, have tanked the past several days as the yield curve turned against them. Banks borrowing at short-term rates and lending at longer-term rates see their net interest margins compressed as the yield curve flattens and inverts.
The bull thesis has been that, as in 2016, a dovish Fed shift and Chinese economic stimulus would lift the global economy. A China trade deal has been viewed as another catalyst this year, though the date of a deal-signing summit keeps getting pushed back. While it’s too early to throw in the towel on the bull market thesis, copper prices are signaling that it’s no sure thing.
Bottom line: Don’t worry about the inverted yield curve unless copper prices confirm that we have a problem. Right now, the signal is still fairly weak, but it’s still concerning.